ESG funds invest in companies that have high scores on environmental, social and governance factors. Globally, this theme has been gaining prominence. But in India, it’s still a small non-core theme when it comes to investments.
Many people have strong feelings about environmental and social topics. So ESG funds at times are looked at as ‘putting you money where your mouth is’ and contributing to a cause.
But if we were to consider ESG funds purely as an investment option and leave aside the moral/personal reasons, then does it make sense to invest in such funds?
Let’s first look at what is (or is not) unique about ESG fund offerings.
Are ESG funds really unique?
To be fair, since the investment pool of stocks is the same for all fund categories (within fund category definitions), there is bound to be some overlap between ESG funds and other categories.
To assess ESG funds’ uniqueness, let’s analyse five popular ESG funds in India. We shall compare their underlying portfolios with bellwether indices like the Nifty50 and Sensex, and also with the flexicap, large- and mid-cap funds of the same asset management company (AMC).
Here is what comes out of this comparison:
Overlap with SBI Large & Midcap Fund – 25%Kotak ESG Opportunities Fund (AUM of Rs 1,619 cr)
Overlap with Kotak Equity Opportunities Fund – 54%ICICI Pru ESG Fund (AUM of Rs 1,560 cr)
Overlap with ICICI Large & Midcap Fund – 24%Axis ESG Equity Fund (AUM of Rs 1,838 cr)
Overlap with Axis Growth Opportunities Fund – 42%Aditya Birla Sun Life ESG Fund (AUM of Rs 1,061 cr)
Overlap with Aditya Birla Equity Advantage Fund – 49%
Note – The fund portfolio overlap is a dynamic figure and changes on a daily basis. The data above is based on schemes’ month-end portfolios in March-April 2022.
As would have been pretty clear by now, there is a fair bit of overlap between ESG funds versus the major indices and the same AMCs’ flexicap and large- and mid-cap schemes.
What this means is that even if you invest in a simple combination of index funds and good flexi/large/midcap funds, the underlying portfolio will automatically have a decently large allocation to ESG companies. Hence, for most investors, I don’t think there is a strong investment case for a standalone ESG fund in their mutual fund portfolio.
What about the returns of ESG funds?
The idea of ESG is about social consciousness and taking a stand. But in investments, it’s more about getting returns.
A noted professor who is revered in the investment world questioned the premise of ESG itself—if being or doing good means less risk taking (on E, S and G parameters), then it might mean lower returns for investors eventually. The other view is that if a company is doing well on the ESG front, it means it is protected from risks on that front and, hence, can potentially do better than companies who score poorly on ESG factors.
But that debate aside, if you dive further into the underlying portfolios of ESG funds, it will become evident that allocation to the top 10-15 stocks making up the majority of the portfolio is towards large-caps. So generally, the return profile of ESG funds is expected to be in line with large-cap index returns with slight outperformance occasionally. Also, ESG funds in India are a new phenomenon and, hence, do not have a long enough track record that can be relied on. That is another factor that makes it difficult to base decisions on the returns of these funds.The idea of ESG is still at a nascent stage in India. Add to it that the ESG dataset itself is not too reliable, and I think it’s too early to start betting on this theme. In years to come, ESG funds might go mainstream and rise above their currently thematic image. As and when that happens, one can rethink the place of ESG funds in the core portfolio. Till then, it’s better to skip this category.